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News that the Greek bond buy scheme did not
get sufficient takers to reach the 30 bln euro target set the
commentariat ablaze. This may prove to be a minor
technicality as Greek banks initially offered 75% of the Greek
bonds but were prepared to pitch them all if necessary to ensure
EU aid is forthcoming, which is the source of their
recapitalization funds.
The bigger story is the fall of the Monti technocrat government
in Italy. Berlusconi's PDL party pulled support by
abstaining economic reform votes at the end of last week.
After a series of consultations with the Italian president, it
appears that parliament will not be dissolved until two important
pieces of legislation are approved, the 2013 budget and financial
stability measures. The former is needed for obvious
domestic reasons. The latter is needed to maintain
credibility in EMU; assuring its partners.
As the situation was unfolding on December 7, Italian bonds fared
well, with the 10-year benchmark yield dropping 5 bp. In
comparison, 10-year Spanish yields fell 2 bp. On the week,
the Italian yield rose 3 bp, while Spain rose 14. Italy's
10-year generic yield is about 93 bp below Spain's. This is
at the wider end of the in recent months. Recall that
end of 2011, Italy was paying a 200 bp premium.

With parliament likely to have been dissolved in any event by the
middle of next month to prepare for spring parliamentary
elections (must be held within 70 days of the dissolution of
parliament), it is not exactly clear why Berlusconi chose now to
pull the plug. As in many things of this nature, the
decision may have been over-determined.

There are PDL politics to consider. It was to hold a
primary and Berlusconi had to make a decision whether to run or
not. There are politics in among the opposition to
consider. The PD had just picked their leader. The
old guard carried the day as the party leader Bersani turn aside
a challenge by the charismatic Renzi. Berlusconi may have
seen this as an opportunity. Recall that last year when
Berlusconi was pushed out, it was not because of a convincing
alternative by the opposition, but because of the hostility he
arose internationally. Proof of that, of course, is Monti's
technocrat government.

Berlusconi may have also been emboldened by the economic data.
Unemployment continues to rise. The economy remains mired
in a recession. As this Great Graphic showed Monti's
support continues to slump, and he draws little support from the
sharp decline in bond yields over the past year.
Berlusconi's timing also corresponds to the new property
tax that goes into effect.

S&P warned before the weekend that it would consider lowering
Italy's rating if the recession continued well into 2013.
The Bloomberg consensus currently forecasts precisely that.
The economy is expected to contract through Q3 13.
Last week, the ECB staff cuts its 2013 euro area growth
forecasts too.

The latest polls show the center-left PD with a 15 pt lead over
Berlusconi's PDL. There is also the 5-Star movement, which
is the protest party, which like in other countries has emerged
during the crisis. On programmatic grounds, the 5-Star
shares much in common with the PDL, including a skepticism of
participating in monetary union. Both 5-Star and the PDL
are based on single personalities and it is not clear that all of
Italy is big enough for the egos of Berlusconi and Grillo.

More worrisome for investors, is a renewed alliance between the
Northern League and the PDL. The risk is that it retracts,
dilutes or in other ways backtrack from the necessary, even if
insufficient reforms of Monti's government.

There are still numerous moving pieces. It is not clear
whether Monti government can pass electoral reform during its
waning days. It is not clear if the local elections, in
which the left tends to do better, will be held before, with the
national election (as the PDL wants) or afterwards. If the
PD wins, it is possible Monti becomes the next President of
Italy. A hung parliament could see Monti remain Prime
Minister, either in a technocrat form or as a compromise
candidate with a parliamentary majority.

Regardless of the particular details, the political risk in Italy
has risen and Italian bonds will likely suffer as a result.
It could have knock negative repercussions for the euro.
With the latest turn in Italian politics, Italy may leap
frog over both Greece and Spain as the source of angst for
investors and policy makers.